When is a Loss a “Loss”

1. CLEARED FOR PUBLIC RELEASE When is a Loss a “Loss” Presented By: Kendrick Dickerson Kendrick.dickerson@dcma.mil May 2, 2013

2. Learning Objectives • At the end of this session, attendees will know: • The regulatory definition of “loss of Government property” (FAR 45.101 and DFARS 252.245-7002) • The difference between “loss of Government property” and reasonable inventory adjustments • FAR and DFARS requirements on “loss of Government property” including: • Government requirements (policy/oversight) • Contractor requirements (reporting & disclosure) • Government’s policy on self-insurance • Contractor, property administrator, and contracting officer responsibilities

3. First things First What is a loss? Losses are: “…unintended, unforeseen, or accidental loss, damage or destruction of Government property that reduces the Government’s expected economic benefits of the property.” “Loss of Government Property” as defined in the Federal Acquisition Regulation 52.245-1, APRIL 2012 But there is much more to the story…

4. What is Gov’t Property? Assets Inventory/OM&S PP&E Real Property Personal Property Repairables Consumables Internal Use Software Land 2017: DoD audit readiness goal! Facilities Equipment 2017 Military Equipment Buildings General Purpose Equipment Structures Linear

5. Government Property (cont.) Assets Inventory/OM&S PP&E Real Property Personal Property Repairables Consumables Internal Use Software Land Distilled into four (4) types under the Federal Acquisition Regulation Facilities Equipment Military Equipment Buildings General Purpose Equipment Structures Linear

6. “Contract Property” Assets Personal Property 1 Equipment Material Special Tooling Special Test Equip. 4 3 2 For Repair • 1. Equipment (for use or repair) • 2. Special Tooling • 3. Special Test Equipment • 4. Material For “Use” 4 types of contract property

7. Current Regulatory Landscape • Federal Acquisition Regulation (FAR) • Part 45-Government’s Policy • Clause 52.245-1 (June 2007, August 2010, April 2012) • Defense Federal Acquisition Regulation Supplement (DFARS) • Part 245—DoD Policy • DFARS clauses: • 252.211-7007 (Reporting of GFE to the DoD UID Registry)* • 252.245-7001 (Tagging, Labeling and Marking of GFP) • 252.245-7002 (Reporting Loss of Government Property) • 252.245-7003 (Contractor Property Management System Admin.) • 252.245-7004 (Reporting, Reutilization, and Disposal) • Procedure, Guidance and Information * Under revision: DFARS case 2012-D001

8. The Regulatory State • Federal Acquisition Regulations System (Title 48 of the U.S. Code of Federal Regulations (CFR)) • Federal Acquisition Regulation = Chapter 1, Parts 1-99 of 48 CFR • Defense Federal Acquisition Regulations = Chapter 2 , Parts 200-299 of 48 CFR • FAR: provides uniform policies and procedures for acquisitions by executive agencies of the Federal Government • Issued and maintained by (DoD), General Services Administration and the National Aeronautics and Space Administration • DFARS: issued and maintained by DoD • DoD specific; delegations of FAR authorities

9. Background • “Contract property” losses • Challenging • Complex (but not complicated) • Often misunderstood • Many inter-connecting parts • Until recently, “loss” was not defined • “Losses” were just about anything; e.g., “shortages,” “variances,” destructive testing (purposeful), inventory adjustments, normal wear and tear, manufacturing defects, maintenance actions • Wide swings of interpretation • Result: • Inconsistent reporting • Inefficiency (= cost)

10. What does the FAR say?

11. What are contractors required to do? • Lets look at basic requirements • FAR 52.245-1 (APRIL 2012) The Contractor shall have a system of internal controls to manage (control, use, preserve, protect, repair and maintain) Government property in its possession. • A stewardship responsibility: “Contractor’s responsibility extends from the initial acquisition and receipt of property, through stewardship, custody, and use until formally relieved of responsibility by authorized means, including delivery, consumption, expending, sale (as surplus property), or other disposition, or via a completed investigation, evaluation, and final determination for lost, damaged, destroyed, or stolen property.”

12. Contractor Resp (cont.) • What makes a good system? • Must be “adequate”*(satisfy the requirements of FAR 52.245-1) • Strong management • Up-to-date • Strong internal controls • Timelines where they make sense • Clear lines of authority • Outlines organizational accountability • Describes methods for performing tasks • Addresses (additional) contract terms and conditions *and approved under the DFARS BSR

13. Relief of Responsibility (cont.) • Relief of stewardship responsibility. Contractors are granted relief when: • Property is consumed or expended or otherwise accounted for, in the performance of the contract, INCLUDING reasonable inventory adjustments of material as determined by the property administrator; • Property administrator grants relief of responsibility and liability for loss of Government property • Notice! • 1) adjustments; and 2) “loss” are broken out separately • This is intentional Why? Because adjustments and “loss’ are two different things • Defined differently • Managed differently • Reported differently

14. So then, what exactly is a Loss of Government property as opposed to a (reasonable) inventory adjustment? Let us contrast and compare

15. Losses are… We know from the previous slide that losses are: “…unintended, unforeseen, or accidental loss, damage or destruction of Government property that reduces the Government’s expected economic benefits of the property.” “Loss of Government Property” as defined in the Federal Acquisition Regulation 52.245-1, APRIL 2012

16. Losses are (cont.) • Includes: • Property that can’t be found after a reasonable search • Theft • Damage or destruction from unexpected incidents rendering the item useless for its intended purpose • Does not include: • Reasonable inventory adjustments • Purposeful destruction testing • Obsolescence • Normal wear and tear • Manufacturing defects • So…we now know what a loss is/isn’t

17. Okay then, so what exactly are inventory adjustments? • The better question is—what are reasonable inventory adjustments? • Neither the FAR or DFARS offer a definition • GOOGLE: • Inventory adjustments: 27,100,000 results • Reasonable inventory adjustments: 7,070,000 results

18. Reasonable Differences: • “Losses that occur naturally as a result of shrinkage, residue from the loading process, material sinking into the ground, etc. Such losses can be expected to fluctuate, depending on the commodity, method of storage, etc.” • DNSCM 4145.1

19. Inventory Adjustments (cont.) • Inventory adjustments must be reasonable • Inventory adjustments must be: • Reasonable (reference FAR 31.205-26(c) and 52.245-1) • Pre-defined, not upon arrival. In other words, documented in the property management procedure • Posted to the accountable property record (IAW procedure); typically not “reported” to the property administrator; contractor adjust records internally—without PA approval/involvement • Why…because the process should have already be documented and agreed to in the property management procedure (PA reviews adjustment mechanisms and documentation during the review) • Considered “loss of GP” if not defined in the procedure (in which case, the PA must review, approve, etc.)

20. Oh, by the way… • Reasonable inventory adjustments are also mentioned in FAR Part 31: • FAR 31.205-26: “Reasonable adjustments arising from differences between periodic physical inventories and book inventories may be included in arriving at costs…” • PS: “Property” is mentioned in many “FAR” off places—always look around

21. Lets take it a step further… What does the DFARS say?

22. DFARS Definition of Property Loss • DFARS clause 252.245-7002 (FEBRUARY 2011) • Loss of Government Property: “…unintended, unforeseen, or accidental loss, damage or destruction of Government property that reduces the Government’s expected economic benefits of the property.” • Notice anything? • Same definition as the FAR • Both FAR and DFARS have the same definition of “Loss of Government Property” And…

23. DFARS(cont.) • We see the same inclusions and exclusions: • Includes: • Property that can’t be found after a reasonable search, theft • Damage or destruction from unexpected incidents rendering the item useless for its intended purpose • Does not include: • Reasonable inventory adjustments • Purposeful destruction testing • Obsolescence, normal wear and tear, manufacturing defects [From DFARS clause 252.245-7002 (FEBRUARY 2011)]

24. So, as you can see, both FAR and DFARS say the same thing…but, …the DFARS takes things a bit further!

25. Reporting Requirements • DFARS 252.245-7002 • Paragraph (b) (1): “The contractor shall use the DCMA eTools software application for reporting loss of Government property” • Paragraph (b) (2): “Unless otherwise provided for in this contract, the requirements of paragraph (b) (1) of this clause do not apply to normal and reasonable adjustments of non-sensitive…losses of low-risk consumable material such as common hardware, etc. Such “losses” are typically a result of normal process variation.

26. “Normal Process Variation” • So, what is normal process variation? • Better question: what is variation(?): • Variation is: “A change in data, a characteristic, or a function that is caused by one of four factors:”* 1) Special causes; 2) Common causes 3) Tampering; 4) Structural variation • For today, we will cover two (2) types of variation: • Common cause: chance, not assignable, natural pattern • Special cause: assignable, definable, unnatural pattern • Easy to distinguish • Commoncause: predictable; not a surprise • Special cause: a surprise; not predictable *DoD LSS Green Belt Course

27. Comparison of Variation Types Special Cause Common causes, for example, could result from equipment out of adjustment. Common Causes Special causes, for example, could result from someone tripping over the shooter when the gun is fired

28. Pop Quiz Example for educational purposes only Is this normal variation? Source: http://www.nasa.gov/pdf/65776main_noaa_np_mishap.pdf

29. Inventory Adjustments (cont.) • So, normal variation can be identified as being produced by common causes • Back to the DFARS clause: The Contractor shall report losses of Government property outside normal process variation; e.g., losses due to— • Theft; poor storage • Lack of physical security • Acts of God • Why? • Because these events would not likely be attributed to common causes

30. "When calculating inventory record accuracy, it is necessary to define what will be considered an error. An error can be defined in various ways, including (1) any error in the item record, such as location, description, and quantity or (2) quantity errors exceeding established tolerances. Tolerance is a range within which an actual value or quantity can disagree with the inventory record and still be considered accurate for the purposes of calculating inventory record accuracy." Executive Guide: Best Practices in Achieving Consistent, Accurate Physical Counts of Inventory and Related Property GAO-02-447G (March 2002)

32. What About FAR Reporting Requirements? • FAR reporting requirements [52.245-1(f) (vi) (A)]: “Unless otherwise directed by the Property Administrator, the contractor shall investigate and promptly furnish…a written narrative of all incidents of loss damage, destruction, or theft, as soon as the facts become known or when requested by the Government.” • You will notice—the FAR does not say: “… unless otherwise directed by the Property Administrator, the contractor shall investigate and report to the Government all incidents of inventory adjustments.” • Why? Another pop quiz!

33. Reporting Requirements (cont.) • Why? Because losses and adjustments are two different things • As we said earlier…contractors are granted relief when: • Property is consumed or expended or otherwise accounted for, in the performance of the contract, INCLUDING reasonable inventory adjustments of material as determined by the property administrator • Bottom Line: Both FAR and DFARS language deliberately distinguishes between losses and adjustments • And so should you!

34. PA Responsibilities • So what happens in a real “loss of Government Property” situation • First • Review: the contract (The Gov’t generally self-insures, but be mindful of unique contract terms and conditions) • Second: • Examine: facts and circumstances • Third • Determine casualty; nexus to the contractor’s property system; is a deficiency involved(?) • Appropriateness and effectiveness of corrective actions • Relieve contractor of responsibility and liability or recommend the Contracting Officer hold contractor responsible/liable

35. What if the loss occurred at a sub? • The FAR is “blind” to where the loss occurred • The prime contractor is responsible for its subs • The contract terms and conditions for liability are between Government and prime contractor • “Where” does not matter to the FAR; what matters is who signed the contract; i.e., who is accountable • However… • The prime is required to flow down to its subs the “appropriate” risk of loss provision • If the prime flowed down full risk of loss and held its subcontractor financially responsible, the Government would be entitled to the monies received (“otherwise reimbursed”)

36. CO Responsibilities • Assuming the PA recommends the contractor be held responsible and liable • Review the PA’s recommendations • Determine: • The extent of contractor responsibility and liability • Intrinsic value of the property (PAs can assist here!) • Is the property still needed for contract performance (?) • If damaged, can the property be repaired (?) • Appropriate form of recovery • Repair • Replace • Other; i.e., financial restitution

37. Contracting Officer Resp. • Review PA’s recommendation • Determine: • Extent of contractor liability—what does the contract say? • “Intrinsic” value (value to the owner) • Dynalectron Corp vs. U.S. (ASBCA No 29,831; 85-3 BCA para 18,320) • Appropriate form and method of recovery • Repair • Replace • Other ($) • Make the call • Inform contractor

38. Liability Policy • The Government generally self insures against property loss- “The magnitude of the government’s resources obviously makes it more advantageous for the Government to carry its own risks than to shift them to private insurers at rates sufficient to cover all costs, to pay their operating expenses, including agency of broker’s commissions, and to leave such insurers a profit.” (19 Comp. Gen 211, 214 (1939)) • The FAR provides basic policy at FAR 45.104

39. GP is Lost or destroyed. GP is Lost or destroyed. Government has NO Government STILL has a current or probable current or probable Future need. Future need. LIABILITY VALUATION: LIABILITY VALUATION: SCRAP VALUE REPLACEMENT SCRAP VALUE REPLACEMENT GP is damaged GP is damaged Government has NO Government still has a current or probable current or probable Future need. Future need. VALUATION: VALUATION: SALVAGE REPAIR SALVAGE Intrinsic Value

40. Bottom Line/Take Aways • So now we know what losses are-- • Reasonable inventory adjustments are not losses • Loss of Government property are not (cannot be) reasonable inventory adjustments • Reasonableness must be pre-determined—not upon arrival • LOSSES always apply to Equipment, Special Tooling or Special Test Equipment –and high-risk ; i.e., sensitive property • Inventory adjustments NEVER apply to Equipment, Special Tooling or Special Test Equipment • LOSSES sometimes apply to Material—but not always Why is all this important?? Your turn!

41. Summary Conclusions • It’s important to stress that the concepts presented here are general guidelines • Individual circumstances will vary • Is the contractor’s system adequate/approved? • Does it have significant deficiencies? • Is sensitive property involved? • Much preparation needs to go into ensuring these guidelines apply • None of this happens “upon arrival” • Property administrator must agree • Collaboration is key

42. ANY QUESTIONS?

43. BACK UP SLIDES

44. PMSA • Property Management System Analysis • A form of compliance audit. Engagement/approach can differ from contractor to contractor. Depends on: • PA’s Risk Assessment: High/Moderate/Low • How contractor is structured; one overarching system may consist of several assessable units; OR each assessable unit may itself be a separate system (if the processes at each assessable unit are sufficiently distinct) • Criteria: does each unit contain like business processes/internal controls; are processes centralized or widely distributed; e.g., do separate locations have their own controls? • Note: assessable units may fall under the same disclosure statement; however, this is not a factor for conducting a PMSA/approving or disapproving the contractor’s system • Tracked in CPAS by primary CAGE

45. PMSAs (cont.) • “Standard” • On site at contactor facility • Formal testing of contractor’s system; i.e., statistical sampling, physical reviews, entrance & exit conferences, etc. • Analysis of applicable property life cycle processes: • “Limited” • Desk Audit • Interview contractor personnel; series of questions covering each applicable process • Validate through documentation as necessary

46. Liability Policy (cont.) • FAR 45.104, Responsibility and Liability for Government Property • [Generally]… contractors are not held liability for loss of Government property under the following types of contracts: • Cost-reimbursement contracts • Time and material contracts • Labor hour contracts • Fixed-price contracts awarded on the basis of submission of cost or pricing data [by default, this means FP contracts of the negotiated variety] • So…what contract types are missing from this list? • Fixed-price contracts awarded NOT on the basis of submission of cost or pricing data

47. Liability Policy (cont.) • Fixed-price contracts awarded NOT on the basis of submission of cost or pricing data can be either: • Negotiated contract (FAR part 15) • “Competitive” (non negotiated/FAR part 14) contract (sealed bids)—in such cases, award is based on price and price-related factors • In 2011, DoD added* one more contract type to the list of those where the Govt would self-insure: Negotiatedfixed-price contracts awarded on a basis other than submission of cost or pricing data * DFARS case 2010-D018

48. So for DoD…the policy is now: • [Generally]… contractors are not held liable for loss of Government property under the following types of contracts: • Cost-reimbursement contracts • Time and material contracts • Labor hour contracts • Fixed-price contracts awarded on the basis of submission of cost or pricing data • Negotiated fixed-price contracts awarded on a basis other than submission of cost or pricing data (DFARS allowance) • So…what contract type is now missing from this list? • Non-negotiated fixed-price contracts; i.e., sealed bid contracts (FAR part 14)

49. FP COMPETITIVE SUB K No issue FP COMPETITIVE P P P Prime is liable regardless of flow down If Full or Limited Liability Flowed Down PRIME K: Full Liability CR, T&M, 0r FP NEGOTIATED FP COMPETITIVE SUB K Issue! P P P PA should not relieve prime until ($) compensation resolved PRIME K: Limited Liability If Full Liability Flowed Down

50. CR, T&M, 0r FP NEGOTIATED SUB K CR, T&M, 0r FP NEGOTIATED No issue P P P PA may relieve prime of liability And prime relieve sub. PRIME K: Limited Liability If Limited Liability Flowed Down CR, T&M, 0r FP NEGOTIATED FP COMPETITIVE SUB K Finding PA request Corrective Action to PMS P PCOny P Prime should have flowed down full liability! PRIME K: Limited Liability If Limited Liability Flowed Down